BTC Markets' Treasury Submission on Digital Asset Platforms

As a leading Australian digital asset exchange, BTC Markets submitted a comprehensive response to the Treasury's proposal paper for regulating digital asset platforms.

This post is our submission to Treasury which reiterates our ongoing commitment to supporting the growth of digital finance in Australia and globally.

We encourage further discussion and collaboration to develop appropriate and effective regulations for the digital asset ecosystem.

1 December 2023

Director Crypto Policy Unit

Financial System Division

The Treasury

Langton Crescent

PARKES ACT 2600

COMMENT ON TREASURY PROPOSAL PAPER FOR REGULATION OF DIGITAL ASSET PLATFORMS 

BTC Markets Pty Ltd (BTCM) is an Australian digital asset exchange. This year marks our tenth in operation. We have over 325,000 Australian clients who have traded more than AU$25bn dollars. Our sister company, BTCM Payments, holds an Australian Financial Services License (AFSL) for non-cash payments and general advice. We hold ISO 27001 certification and are working towards SOC II certification. This reflects our commitment to operating at the highest standards and mirror international best practices.

BTCM believes there is a need for appropriate, proportionate industry regulation. We have been public with this expectation and are grateful for the work that has taken place so far. 

We agree with the stated objectives to protect consumers; support innovation; maintain international alignment with our peers; and create regulation that can be flexible and responsive to the changing environment. Centering regulations on the vulnerabilities of intermediaries should meet the requirements to protect consumers. Creating a new financial product, a ‘digital asset facility’, under the existing financial framework maintains consistency. Asper our submission to Treasury in May 2022, we would like regulation that is “fit for purpose, risk-focused and light touch… By focusing on the risks being mitigated, it will allow for a vibrant, innovative ecosystem in Australia.” We can be assured there will be great strides of innovation to come.

There are two key risks in the proposal that must be addressed from the outset. Firstly, it is the requirement 5.1. (d) (v) Measures for recovering tokens sent by account holders to the platform provider’s correct address on the wrong network, where technically possible, and other user error risks. 

Every recovery requires a very manual process of retrieving and handling a specific private key. Any manual handling of a private key is extremely risky and requires overriding many security policies. When recovering assets from non-supported chains the recovery keys or seed needs to be moved from a secure location and onto a device to sign a transaction. In the case of custodians, bringing the seed online could create vulnerabilities in the security of billions of dollars of customer funds. Recovery keys/seed are designed for use in an emergency only. This practice may negate insurance, where policies would specify that backup seeds should never be used other than their exact purpose. Some of the unsupported tokens or networks can require downloading and using unapproved software that may increase security risks or be downright malware. In short, this regulation would codify potentially risking everyone’s crypto for the benefit of another user’s error.

The majority of platforms do not support this practice now due to the risks. To make a known vulnerability applicable wholesale across the entire Australian ecosystem would be a folly.

Secondly, consistent with our May 2022 submission, a minimum standard applicable is the segregated, onshore custody of client assets. This is a core protection for Australian investors with no justifiable reason for compromise. Assets outside of Australia are outside of the protection of Australian laws. This gap is also outside the stated objective to protect consumers in this asset class.

In a jurisdiction with experience of bankruptcy issues with digital asset platforms this is a requirement. Japan learned from prior experiences and created laws ensuring Japanese client assets are held onshore. Unlike the 50,000 Australian FTX investors, FTX Japan customers are not involved in the FTX US bankruptcy proceedings for example. Japanese laws protecting Japanese investors.

We also know that it is not an issue for international custodians to support overseas markets. Coinbase Custody International set-up in Dublin to service the European market in response to their incoming custody requirements. Onshore custody will not be an issue for any business who value their Australian clients to do the same in this jurisdiction.

Minimum standards are to include assets being held on trust. Our current business model is straightforward and facilitates the holding of tokens on trust. We maintain full client reserves, 100 per cent of client assets, meaning we don’t utilise client assets except on their direct instruction i.e. buy, sell, withdrawal orders. The proposed requirement for segregated custodian relationships strengthens this further. It would be the tokens themselves are held with a custodian.

In other matters, a key concern relates to the Net Tangible Assets (NTA) requirement of 0.5% of assets under management (AUM.) The purpose and history of the NTA is understood where resources are needed for an orderly wind-down of complex businesses. The standard solvency and cash need requirements of an AFSL play a role here. It is also understood that the specific percentage is inherited from traditional AFSL practices, calculated by assessing funds under management (FUM.) In traditional asset classes, it is possible to control FUM to a degree, using lock-in periods and closing funds to additional investors. Traditional finance also doesn’t experience the volatility swings of cryptocurrencies. For instance, 1st December 2020 saw bitcoin trading at approx. AU$29,000. By 1st January 2021, it was over AU$47,000. This illustrates the challenges of calculating an NTA requirement intrinsically linked to the value of cryptocurrency at any one point in time. This is recognised in the proposal with reference to the challenge of monitoring thresholds with the complexity of high volatility and/or illiquid markets.

We acknowledge the need for an NTA but request that the method of calculation be changed. For example, with exchanges using a third-party custodian, the majority of client assets will be under their purview and fiat balances likewise with financial institutions. The NTA requirement could then be based on warm and hot wallets i.e. crypto assets under the control of the license holder. 

BTC Markets conducted an Australian investor survey in 2021. One of the main points of feedback was the desire for professional advice with regards to digital asset investment. We know there is increasing interest from the professional advisory sector to engage with crypto assets. As financial advisors are currently unable to provide any advice to clients regarding crypto, the gap has been filled. In some instances, by some individuals without experience or appropriate training. It would be a reasonable expectation that once professionals are able to advise on cryptocurrency in general, that the standards will naturally rise. For any products outside of finance, it is not appropriate for it to be encompassed under an AFSL regime, including any non-financial cryptocurrency or digital asset.

Recognition of the unique position of token holders is important. Obligations that recognise primarily the physical security of staff being paramount. Removing a requirement for the publication of physical office addresses would be one immediate answer. This would sit outside a due diligence and audit requirement, but not publicly available. Data points could be collated by ASIC but remain confidential to the wider public.

The proposed requirement that all platform providers must act against market misconduct may be challenging to regulate. Rather than an offence, reasonable efforts pursuant to platform activity can be a caveat to retaining an AFSL.

For section 5.1. (d), relating to token trading platforms, a feature of blockchain technology is its youth. As with any nascent technology there are foibles that need to be worked through. Individuals engaging with blockchain and crypto in any capacity are to educate themselves, as they would any new technology. Blockchain is a technology that works on absolutes, so errors are often final. Regulation should support education channels to ensure consumers are aware of risks but exchanges cannot be responsible for correcting user errors.

Issues with network congestion, transaction fee spikes for example are matters outside the control of any one platform. Similarly, there are residual risks that remain with forks, rollbacks and the use of bridges for instance. Our policies and procedures have due diligence incorporating technical audit requirements for partners and networks. With the youth of the technology and the ecosystem around it, best efforts and ‘reasonable man’ tests should apply.

Regarding staking, providing the ability to unstake is a core functionality that will be incorporated as part of our platform product design. However, there are matters outside our control regarding unstaking (or unbonding) as per requirements of the blockchain. For example some chains have lock-in periods, similar to some financial products These time-frames can be hours to days. Full details on timeframes, expected rewards, fees, eligibility and the mechanics will be provided and acknowledged by clients prior to staking. 

For sanctions filtering on staking, it is unclear how that would work. We currently have sanctions filtering on transactions coming in and out of our platform. Staking is accessible worldwide and would be impossible to police to see if sanctioned nations or individuals are participating via their own node for instance.

Similar to above, the relative immaturity of blockchain and the support ecosystem means that best efforts and reasonableness test should apply.

Margin lending, (f) (i) non-financial digital assets are not marketable securities. They sit outside the definition of security, being a non-financial asset and there is no guarantee of being marketable. Meaning it could be an illiquid asset of value to a niche segment of the market. A bespoke lending activity under the digital asset regime is a more sensible, commensurate approach.

We are committed to supporting the growth of digital finance in Australia and around the world. BTCM would welcome the opportunity to discuss any of the points raised in more detail.

Yours sincerely, 

Caroline Bowler 

CEO, BTC Markets

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